How shares make money – Just One Lap

If you hope to grow your wealth more than inflation, you need to accumulate assets. You can turn your money into a physical asset like a business, or a paper asset like a share. When you buy a share, you become a part-owner of a business. This entitles you to some of the company’s profits. The profit gets paid out in the form of dividends, which is the first way shares make money. As long as you hold a share, you get some of the profit. If you use your dividends to buy more shares, your investments have an opportunity to compound.

You can also make money from an asset by selling it at a higher price than you paid for it. In the world of share investments, this is called a capital gain. In the world of physical businesses, it’s called a profit. They mean the same.

This way of making money from shares raises many practical questions. In this article we’ll explain why shares make money over time, offer some ideas on choosing the right shares and explain why it isn’t a good idea to put all your money in a single share.

Share prices change every day

In the short term, share prices go up or down depending on how many people want to buy the share. If more people want to buy the share, the price goes up. If there are more sellers than buyers, the price goes down.

It’s difficult to predict what a share’s price will do, because you don’t know if there will be more buyers or sellers on any given day. It’s also not always obvious why people suddenly want to buy or sell a share.

This daily seesaw of share prices is called volatility. You don’t know if a share’s price will go up or down in the short term, so the price could be higher or lower than you paid when you want to sell. When we talk about risk in the context of share investing, we mean a share price can be lower than what you paid. For this reason, share investing is recommended for people who can afford to wait until a share is at the right price before selling.

Share prices tend go up in the long haul

Over time, most share prices go up by at least inflation. The companies whose shares you buy are also the companies selling you products at inflated prices. When a grocery store adds 5% to the price of goods, that money gets reflected in the business’ books. People watching that company closely will notice the additional income and the share price will rise to reflect the higher earnings. Any profits over inflation also gets reflected in the share price, making it higher over time. If a company is performing poorly however, its share price won’t go higher over time because nobody would want to risk buying it.

When a share price doesn’t rise

Sometimes a company goes through a hard time. This can be due to the environment in which it operates or bad management. When that happens, fewer investors are interested in buying that share for fear of losing money. Sometimes companies even fail completely and the share becomes worthless. If you hold a share in a company whose share price has fallen and doesn’t go back up, you will be forced to sell the share for less than you paid. In the world of share investing, this is what we mean by losing money. Unless you put everything you have into a single share whose share price went to R0, you will never lose all your money buying shares.

What to do about finding the right share

Since share prices fluctuate in the short term, but rise in the long run. So you should only invest money you can afford to live without for a long time. It’s therefore important to ensure you have the right financial foundation in place.

Since some share prices fall, never to rise again, you shouldn’t invest all your money in one share. If you hold one share in 10 companies and one company’s share price goes to R0, you’ll only have lost 10% of your overall investment. If one of the other shares go up by 200%, you’ll soon forget about the loser because your portfolio as a whole would be making money. Index-tracking products like unit trusts and ETFs (Exchange Traded Funds) allow you to invest in a number of different shares all at once. These products kick out bad shares automatically and invest in good ones so you don’t have to worry about finding the right shares. You can find some unit trust suggestions here.

It only works when you break up

You only make or lose money when you sell a share. If the stock market is having a hard time and every share you own is worth less than you paid for it, having enough time to wait for prices to go back up is crucial. Shares can be worth less than you paid, but you don’t get less for them until you sell. In the meantime, they’ll continue to earn dividends to ease the pain.

Once more, with feeling

Aside from dividends, shares make money when you sell them at a higher price than you paid. Share prices are all over the place every day, but over time most of them go higher, so you need to give them time to work. You only make or lose money from share investing when you sell shares. Until then, all your profits and losses are on paper. Investing in multiple companies at once is a way to protect your money, because if one or two shares lose money while the rest are making money, you’re making money.

Being outstanding with your money doesn’t have to be hard. This series of articles will give you all the tools you need to get your house in order to start investing.

This series of articles was sponsored by OUTvest, and written by Just One Lap in 2018.  It’s timeless wisdom that needs to be out there – in public spaces where it can feed into ongoing discussions about long term financial wellness. We are republishing this series to make Fridays outstanding (but you’re welcome to read ahead).